July 10, 2015

WSJ: A Dearth Of Tech IPOs May Mask Bubble Trouble

The latest bubble chatter in the tech industry came from Fitbit, the maker of high-tech pedometers. Fitbit went public last month at a $4.1 billion valuation, and the stock price has more than doubled. Is a company that made $132 million in profit last year worth almost $9 billion? Major Silicon Valley players don’t think so. Sam Altman, who runs the startup accelerator Y Combinator, called the market last month a “mega bubble” that “won’t last forever.”

But since fewer startups seem willing to submit themselves to the disclosure and discipline of the public markets, how would we know? The Wall Street Journal’s Billion Dollar Startup Club shows 100 private companies valued at more than $1 billion. Yet this year there have been only eight venture-capital-backed initial public offerings compared with 115 in all of 2014.

Aside from Tesla and a few others, most of the hot companies with eyebrow-raising values are staying private. Uber is rumored to be raising $2 billion in funding for a valuation of $50 billion. Blue Apron, which ships three million meal kits a month to hungry millennials, has taken in $135 million at a $2 billion valuation. Food-delivery companies Instacart and Delivery Hero are worth a few billion each.

Yet none is going public. The delay can perhaps be blamed in part on Sarbanes-Oxley, a 2002 law that beefed up oversight and made it more expensive to be a public company. There’s also the 2012 JOBS Act, which increased the threshold for public reporting to 2,000 shareholders from 500. Whatever the causes, there is no longer a rush to go public if companies can raise sufficient private capital. “Now, after the IPO, it’s much worse,” Alibaba co-founder Jack Ma put it in June. “If I had another life, I would keep my company private.”

As a shareholder and a lifelong bubble watcher, I’m disturbed. Public markets enforce discipline on companies and push them to improve. Look at Facebook. In the first full quarter after its 2012 IPO, the company disappointed Wall Street with only 14% of revenue from mobile—phones, iPads and other portable devices. Now mobile accounts for 98% of Facebook’s ad growth and almost 70% of its revenue. Markets rule.

That discipline can be tough.

After its December IPO, Lending Clubmissed earning expectations and fell to $14 a share from $28. The stock price of the craft-selling website Etsy has halved in the two months since the company went public. The online advertising company Rocket Fuel went public in September 2013 at $29, soared three weeks later to $65 and is now $7.

But with Uber at $50 billion, surely we’re in a bubble? Remember: A bubble is not created by high valuations. A bubble is a psychological phenomenon in which investors are tricked—by the company or themselves—into believing that a profit stream is sustainable when it really isn’t.

Case in point is the dot-com bust of the late 1990s. Many companies told me at the time that Goldman Sachs or Morgan Stanley would take them public as soon as they could strike a deal with AOL. So AOL would invest on the stipulation that the company buy pop-up ads on various sites within AOL. Thus AOL turned its cash into sales. The madness stopped when companies ran out of money and AOL ran out of companies.

In 1999, Microsoft invested $250 million in the online ailment manual WebMD in exchange for WebMD paying $30 a month for thousands of physicians for dial-up Internet via, you guessed it, Microsoft’s MSN. Amazon invested $30 million in Drugstore.com in exchange for Drugstore.com paying $105 million over three years for a branded tab on Amazon. It all looked good, but it couldn’t last. It is no different from Bear Stearns using its balance sheet to spike mortgage-backed securities from 2005-08.

Today’s startups aren’t passing money in circles like this yet, though I suspect it will happen. With so many private firms holding wads of cash, the ability to use their balance sheets to drive sales will be too tempting. But without the disclosures required of public firms, this logrolling may be hidden from view. As such, Silicon Valley tycoons shouldn’t get jitters over big numbers. A deluge of IPOs would be just the sunshine needed to sustain this much needed reordering of the global economy.